Escalating trade conflict with the U.S. and mounting debt among domestic developers, combined with unprecedented deleveraging, have prompted many critics to claim that China’s property market is entering choppy waters.
The reality is far more nuanced. While some sectors may endure some short-term discomfort, the market is resilient and likely to emerge unscathed from the current turbulence.
Recent government measures, such as those which open up the financial sector to qualified foreign investors and relax FDI restrictions in selected industries, are likely to offset much of any negative impact.
Below we identify the likely consequences of escalating U.S.-China trade conflict and rising debt among Chinese developers, and explain why a major downturn is highly unlikely.
On July 6, 2018, the U.S. imposed tariffs on US$34 billion of Chinese goods. China retaliated by introducing tariffs on the equivalent amount of U.S. goods. Additional tariffs are scheduled to come into force in the coming months.
CBRE believes U.S. tariffs could shave 0.1%-0.3% from Chinese GDP growth in 2018, with Chinese exports to the U.S. in sectors such as machinery and parts, electrical equipment and iron and steel set to be the hardest-hit.
Trade conflict will have the strongest bearing on the industrial and office sectors, although both have seen minimal impact thus far.
In the industrial sector, CBRE understands that a number of industrial manufacturing occupiers, including several firms who are not affected by the first round of tariffs, are considering shifting production to nearby Southeast Asia locations, with Vietnam the most likely beneficiary.
Although the coming months may indeed see some China-based manufacturers outsource production or shift component assembly to markets not subject to U.S. tariffs, recent central government moves to relax foreign direct investment regulations could offset much of the impact.
In June 2018, the National Development and Reform Commission (NDRC) and the Ministry of Commerce (MOFCOM) published new national and free trade zone negative lists outlining prohibited and restricted industries for foreign investment.
The negative list immediately relaxed or removed restrictions on foreign investment across a number of sectors, including agriculture, mining, renewable energy and infrastructure, and also set out a timetable for the relaxation of restrictions in the financial, insurance and automotive sectors.
Several companies have already moved to take advantage of the new regulations. These include Tesla, which in July received approval to construct a production centre in Shanghai. The U.S. electric car manufacturer expects to build up to 500,000 vehicles a year at the new plant. Other first moves include BASF, which has announced plans to invest US$1 billion in Guangdong province.
In the office sector. U.S. companies operating in sectors subject to Chinese tariffs account for just 1.5% of total leasing volume, meaning that the impact on the office market should be relatively small. Office demand from Chinese trading companies engaged in import/export business with the U.S. could also be negatively affected, but such firms represent a very small percentage of leasing volume, estimated by CBRE at under 1.5%.
In fact, office leasing demand could be set to benefit from a timetable for financial market reforms announced on April 10, 2018, by Yi Gang, the newly appointed governor of the People’s Bank of China (PBoC).
Key components of the timetable include opening the insurance industry and related businesses to qualified foreign investors and allowing foreign insurance companies the same scope of business as local companies, effective the end of H1 2018. The government will also ease a restriction requiring foreign insurers to have a representative office in China for two years before they can set up a company.
Also included was an end to foreign ownership caps for banks and asset management companies. Foreign firms will be permitted to compete on an equal footing with domestic financial institutions, thereby providing foreign banks with greater scope to operate on the mainland, which could eventually be reflected in stronger demand for office space.
Ultimately, CBRE believes that the direct short-term impact of U.S.-China trade conflict will be manageable. Any longer-term impact is set to be offset by the government measures outlined above, together with additional steps including increasing domestic liquidity via further RRR cuts; loosening domestic investment; easing the implementation of new regulations on the financial sector; and accelerating the Belt & Road Initiative to enhance trade partnerships and geopolitical ties with emerging markets, particularly those in the Association of Southeast Asian Nations (ASEAN).
It would, however, be negligent not to mention a worst-case scenario, which would involve an escalation of the trade war and both sides imposing further tariffs. The U.S. has threatened to target US$200 billion of Chinese products with a 10% tariff, which would make it impossible for Beijing to respond on a similar scale, as its total imports of U.S. products in 2017 were just US$130 billion. Under this scenario, Beijing could opt to restrict U.S. investment and instruct Chinese firms not to engage with U.S. companies, which would have serious implications for U.S. business activity in China.
Listed Chinese developers face around US$ 110 billion of debt repayments between 2018-2021 and remain subject to restrictions on financial borrowing. Despite widespread talk of mounting credit pressure on developers and an industry under severe strain, CBRE believes that the risk of a market-wide collapse is very low.
The limited number of default cases to date have mainly involved smaller local and private developers. Despite the government’s deleveraging initiative, listed developers have succeeded in finding alternative funding channels, with new issuances of Asset-backed Securities (ABS), such as Quasi-REITs and CMBS, exceeding US$12 billion over the past 12 months.
However, the government recently tightened rules covering new ABS issuance and has also banned developers from selling bonds overseas unless the proceeds are used to repay maturing debt or prevent defaults.
CBRE expects smaller developers to continue to come under strain, which could force them to sell projects (or stakes in them) to larger competitors, and may stimulate some M&A activity. Certain medium-sized developers, many of which have borrowed heavily in recent years in attempts to scale up, may also be vulnerable. Major national developers, which continue to dominate the residential market, are likely to emerge unharmed amid strong demand for residential units in good locations.
The latest data from CBRE Research reveal the China property market to be in healthy shape, with occupier markets reporting strong leasing momentum and the country remaining a magnet for investment. The commercial real estate transaction volume was RMB 84 billion in H1 2018—down 19% year-over-year, but still above the past three years’ same-period average.
While trade conflict with the U.S. has added a layer of uncertainty to the market, its impact will be manageable and largely offset by central government measures to loosen foreign direct investment regulations and open the financial sector to qualified foreign investors, which could eventually emerge as a new source of office leasing demand.
Debt maturity remains a concern but market-wide default risk is unlikely. Major national developers are in healthy shape and alternative funding sources are in place.
Although the central government remains committed to cracking down on speculative activity, with 60 cities still enforcing Home Purchase Restrictions (HPR), CBRE foresees that the high housing price to income ratio, particularly in Beijing and Shanghai, will encourage foreign and domestic investors to consider investing in build-to-rent multi-family apartments, supported by government policies to create a rental housing market.
Henry Chin, Ph.D.
Head of Research, Asia Pacific
Head of Research, China